The Domino’s Pizza Enterprises Ltd (ASX: DMP) share price has come under pressure today amidst allegations the company has been underpaying staff — again!
It is being reported that Domino’s will face a class action lawsuit to be funded by global litigation funding provider Therium Litigation Finance
. It is alleged that the popular pizza chain operator has been systematically underpaying its workers.
This comes just 24 hours after broker Citi upgraded its outlook for the company. So where to from here for the former market darling?
Domino’s Broker Upgrade
Analysts at Citi have taken a favourable view of Domino’s upgrading the pizza chain operators shares to a buy rating with a $44 price target. This constitutes a 15% premium to the share price at the time of publishing. The upgrade was supported by a belief that investors are underestimating the huge potential of the company’s European expansion plans.
Ambitious Growth Plans
Domino’s is aiming to double the size of its store network within the next 10 years. Much of this growth is expected to come from Europe where the company is in the process of rolling out new stores across a number of countries including France, Germany, Luxembourg and Denmark. The company recently reported that they were making encouraging progress in Europe with expansion plans meeting expectations thus far. If Domino’s can successfully execute on its expansion plans the profits of the company are likely to be substantially higher 10 years from today.
As a long term investor, it is important not to focus too heavily and become seduced by the profits alone. This may seem a weird piece of advice but the Australian share market is littered with company’s that were able to grow profits for a time whilst simultaneously destroying shareholder wealth in the process.
Bigger isn’t always better, especially if it coincides with large increases in debt and a reduction in the return on equity the business is able to generate. Investors will ultimately be rewarded by a company’s ability to generate an adequate rate of return not only on the existing capital invested but also on all incremental capital invested into the business.
I am always somewhat cautious when company’s trade on lofty valuations based on the promise of supercharged growth into the future. This caution only increases when expansion plans involve a hefty dose of required capital expenditure and making an entrance into new markets. This is certainly not to say that I am betting against Domino’s but rather that I would need to see a price that I feel compensates me for the risks associated with the aggressive expansion plans.
The Final Word
Whilst I agree with the Citi analysts regarding the huge potential of the European expansion plan, I would question whether they are appropriately pricing in the risk factors involved in such an ambitious growth strategy. Despite the share price having halved since its 2016 peak I still think a lot needs to go right for the current share price to be justified. Therefore whilst I will continue to keep a close eye on Domino’s I won’t be joining the Citi analysts in buying at the current time.
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At the time of publishing, Luke has no financial interest in any companies mentioned.
